Economic Implications Of Surgical Strike Across LoC

CARE RATING Analysis

India conducted a surgical strike yesterday along the Line of Control (LoC) in order to safeguard the borders and security of the nation. The surgical strikes were based on intelligence reports of these terror groups preparing to carry out attacks in India. These strikes came amidst tensions between India and Pakistan, after certain terrorists stormed an army camp in Uri on September 18 and killed 18 soldiers.

The economic implications of this attack will depend on the duration of the ongoing border tensions between the two nations. The report here is divided into 2 parts: immediate and medium to long term impact of the cross border tensions.

Immediate Implications

Sensex and Nifty have fallen significantly:

  • Sensex went down by 465 points and Nifty by 154 points recording 1.64% and 1.76% fall receptively. The day was marked with volatile trading after the markets reacted to the reports of the surgical strike.
  • Government securities (GSecs) yields increased: The 10 year benchmark GSec yield went up from 6.78 % to 6.86%, as the markets remains uncertain and cautious about the strikes and the future course of the ongoing tensions on the border.
  • Exchange rate- Rupee declines: The Indian Rupee which was on a winning streak for the past consecutive three sessions has fallen against the US dollar from 66.47 from to 66.85. The uncertainties in the country coupled with the weak performance of the equity market weighed on the Rupee as well, causing it to weaken.

Medium to Long Term Implications:

The implications will be contingent on the duration of the military activity. It is largely expected that the issue will settle down in the next couple of days. If it does, then the following may be expected in the interim period.

  • Volatility in market: The markets will remain turbulent with the investors remaining wary about the future course of actions and the probable consequences of the same. Higher interest rates, weaker currency and nervous stock markets would be the likely situation. However with fundamentals being strong, it may be expected that the volatility will be with shorter amplitudes.
  • RBI monetary policy action: The RBI monetary policy is due on 4th October. While under normal circumstances we would expect an unchanged stance, depending on the seriousness of the battle and the reaction of the market, the RBI could consider more seriously a rate cut. The chances of such action would increase until Tuesday depending on the course of the tension at the LoC.

The other possibility is of a prolonged tenure of such tension between the two countries which would lead to the following possibilities.

  • Spending on defence: In long term, in terms of sustainability, the government might have to engage in increased expenditure on defence of the nation. This would add to the government stimulus package. The decision will be whether to increase allocations for defence expenditure and cut down on other capex or do so with a higher deficit. The latter will help to keep the pace of activity up.
  • GDP growth is not likely to be affected and the path of around 7.8% could be expected.
  • Industries related to defence will receive a boost which will help stimulate the economy. Metals in particular along with capital goods could receive a boost.
  • It has been observed across the globe that higher defence spending if conducted without other expenditure cuts can improve growth prospects.
  • Inflation would largely be under control especially with a good monsoon and low commodity prices. In the earlier wars in the seventies we were impacted by high crude oil prices which are not the case today. Hence, while demand-pull forces would be there it would be absorbed by the system. A CPI inflation rate of 5-5.5% can be maintained.
  • Trade and Investment: No significant impact expected on either trade or investments flows as Pakistan is not a significant partner. The exchange rate would remain stable with close monitoring by the RBI.
  • The external situation is very strong with forex reserves of around $ 370 bn which can absorb any external shock, which is unlikely.